As a business, you probably do not capture all of the sales you are entitled to and must write them off as bad receivables. The customer may have gone bankrupt, may dispute the charges or might have just defaulted on the payment. Generally accepted accounting principles, or GAAP, directs businesses how to deal with these problems depending on the time that has elapsed and the reasons for the bad receivables.

Initial Input

After a sale is consummated with a contract to pay, accrual accounting mandates that the accountant enter an increase in sales in the income statement and an increase in the amount due from customers as an asset on the balance sheet. This entry is called accounts receivable. If the sale later becomes a bad receivable, the accounts receivable is reduced on the balance sheet and a bad debts expense is recorded on the income statement.

Allowance Method

Under GAAP, the allowance method for bad receivables permits the accountant to slowly write off bad debts rather than taking the entire expense immediately. However, the accountant must make a somewhat subjective decision about how much to write off at any one time and how much she expects to collect. The accountant can use a historical record for her particular company. If those numbers are not available, she can use industry averages for bad receivables.

Direct Write-Off

Before writing off the bad expense in the allowance method, the company must make several attempts to collect from the customer. That includes calls, emails and possibly requesting the services of a debt collector. You also must have a standard period such as one month or three months before a payment becomes a bad receivable. This period will depend upon the industry standard.

Calculation

Under GAAP, bad receivables can be easily counted using the allowance method. For example, your company's historical record shows that if you have not received payment after 90 days, you only have a 50 percent chance of collecting payment and a 10 percent chance after 180 days. If your customer has not paid his $2,000 bill after the 90-day period, you would mark it down on the income statement and balance sheet by $1,000 with a reference to the particular customer. After 180 days, you would then mark it down another $800. At the end of the year, you can mark it down to zero.